Although the worst fears of global recession have subsided, the prospect that the world economy in 1999 will simply repeat last year´s poor performance is discouraging. According to UNCTAD’s Trade and Development Report 1999 (175 pages), released today, "neither a return to stability in the buffeted Asian economies, nor the apparent containment of the Brazilian crisis to its neighbours should hide the immediate downside risks facing the global economy over the near future".
The Report warns that stabilization of conditions in emerging markets does not mean that the underlying problems have disappeared. "There is no ground for complacency, since the systemic forces responsible for the recent turmoil are still present." The continued dependence of many developing countries on highly volatile capital inflows is a major cause for concern (see also TAD/INF/2816). There are also question marks about the ability of the US economy to bring about a smooth adjustment towards a more sustainable rate of growth, and of the EU and Japan to achieve stable recovery.
Winners and Losers from the Asian Crisis
The direct cost of financial turmoil to the East Asian region has been enormous. Income in four ASEAN countries (Indonesia, Malaysia, Philippines, Thailand) fell by 9 per cent in 1998, compared to an increase of 7 per cent in 1996. The attendant problems of unemployment, rising poverty levels and falling social indicators are visible across the region.
Such problems have not been limited to East Asia. Indeed, subsequent financial shocks elsewhere in the developing world, particularly in Eastern Europe and Latin America, and their equally destructive impact, suggest that the century is ending with what could fairly be described as a "crisis of development". Growth in developing countries slowed from 6 per cent in 1996 to under 2 per cent in 1998, and to under 1 per cent if China is excluded.
Contagion has spread through both finance and trade. Net private capital flows to developing countries dropped by 70 per cent between 1996 and 1998. Although forecasting such flows is hazardous, little overall recovery is expected before 2000. Rapidly changing financial flows have, in turn, generated currency volatility and shifts in competitiveness across the developing world.
Commodity exporters have been particularly hard hit over the past year. A fall of one third in world oil prices brought them to the lowest level in real terms for many decades; measured in 1974 dollars, the price of crude oil in 1998 was US$4 a barrel, compared to more than US$10 in 1974 and US$20 in 1980. The price has rebounded in 1999, more as a result of supply cuts than of demand expansion.
The 12 per cent decline in non-oil commodity prices in 1998 was the biggest since the 1970s. Price declines for manufactured exports from developing countries have also been apparent in the past few years; during 1998, export unit values of East Asian NIEs (Hong Kong, China; Republic of Korea; Singapore; and Taiwan, Province of China) fell between 3.6 per cent and 17 per cent.
OPEC exports revenues plummeted by over US$50 billion, and oil exporters as a whole lost more than 6 per cent of their GNP. In Latin America, declines in export prices in 1998 resulted in a loss of over US$10 billion in foreign-exchange earnings; in sub-Saharan Africa, the losses reached almost 2.5 per cent of GDP.
Industrial countries, by contrast, have gained from the collapse of commodity prices and the cheapening of manufactured imports that has resulted from the crisis. The OECD countries saved about US$60 billion in 1998 by importing cheaper oil. It is striking that this sum amounted to more than their total official development assistance for the same year.
The decline in asset prices and the rise in risk premia in global capital markets has produced a flight to quality, benefiting stock markets in developed countries, with knock-on growth effects through higher consumption spending. Consumers in the United States have been on a shopping spree, spending an additional US$400 billion between the second quarter of 1997 and the end of 1998 - more than twice the total annual income of sub-Saharan Africa.
Trade Stalls
Massive import cuts in East Asia have been a major factor in the slowdown of world trade. In value terms, world trade not only failed to grow; it underwent its strongest decline since 1982, with exports falling by 2 per cent. These cuts in 1998 have also played a major role in the re-emergence of major trade imbalances in the world economy not experienced since the 1980s, notably the US$80 billion widening of the US current account deficit in 1998 compared with the previous year.
The decline in oil prices was responsible for nearly 90 per cent of the overall decline in the value of world trade. Together with the decline in non-oil commodity prices, this has meant that, for the first time in 50 years, the share of primary products in world trade fell below 20 per cent. The dollar value of export earnings of developing countries fell for the first time since 1991. This is an additional reason why the Third Ministerial Conference in Seattle of the World Trade Organization (WTO) to be held later this year should serve as an opportunity to revitalize trade, bearing in mind the stimulus that trade expansion could give developing economies. The Report sets out elements of a "positive trade agenda" around which developing countries can establish a united front, with priority given to market access in the developed countries.
Recoveries and Setbacks in Developing Countries
The world economy is estimated to have grown by 2.0 per cent in 1998. Much the same performance is expected this year. Not only is this unacceptable in itself, but it hides a growing rift between the developed and the developing world. In 1998, output in developing countries as a whole grew on average more slowly (1.8 per cent) than population. Moreover, for the first time in 10 years it was less than in industrial countries (2.2 per cent).
Asia’s performance continues to depend on how the crisis and its aftermath are managed; the speed and sustainability of recoveries are varied and uncertain. For the region much will depend on developments in China and Japan. The gradual slowdown in China is giving rise to concern. The severity of the East Asian crisis has led to a slackening of its exports, and so far heavy public expenditure has kept the momentum going. Devaluation may become more attractive if prospects worsen significantly. The consequential risk of broader currency realignment across the region remains a worry.
Despite the continued pursuit of structural reforms, Latin America has suffered a serious setback since growth peaked in 1997 at 5.4 per cent. All the major economies have been affected. The collapse of the Brazilian real in January this year was one major factor of contraction in the region. Despite poor growth, several major countries in the region are running external deficits above the critical level of 4 per cent of GDP. External indebtedness and dependence on foreign capital inflows are again on the rise, and the region is vulnerable to a loss of investor confidence and/or a hike in US interest rates.
In Africa, the much-hoped-for take-off has not happened; the growth rate in 1998 was well below that in 1996 and hardly kept pace with population growth. 1999 is unlikely to see any significant improvement. Over the longer run the crippling burden of external debt and continued reliance on commodity exports place very heavy constraints on faster growth.
After posting positive growth for the first time in 1997, transition economies were badly affected by the Russian crisis in the second half of 1998, resulting in negative growth for the region as a whole. Macroeconomic turmoil continued into 1999, with a further drop in output expected across most of the region. As current account deficits are rising everywhere, the region remains vulnerable to external shocks.
Where Are Europe and Japan Going?
Sustainable recovery in the crisis-hit regions, particularly in Asia and Latin American countries, will of necessity be export-based and hence depend on the pace of economic activity in industrial countries.
To date, rapid growth in the US has been a bulwark against global recession, at around 4 per cent over the last three years, almost double what many had considered its long-term potential. Growth this year is expected to drop closer to 3 per cent. However, inflationary fears are on the rise, and a tightening of monetary policy might trigger a large equity market correction; given the role in the boom played by private spending linked to equity prices, this could produce a harder landing than desired, jeopardizing recovery elsewhere. This policy shift could also lead to higher trade deficits and mounting protectionist pressures. Even if a hard landing is avoided by raising interest rates, this will create problems for the financing needs and trade of developing countries.
The anticipated recovery in Japan, meanwhile, is still just that. A surprise jump in consumer spending in early 1999 is not likely to persist, and a fiscal package set for the autumn of 1999 is still required if the official growth target of 0.5 per cent for the current fiscal year is to stand any chance of being achieved. However, negative growth is still the likely outcome this year. Given the widespread excess capacity and weak balance sheets in the private sector, in the longer term growth will depend on further structural reforms.
The European Union is unlikely to give much of a boost to the world economy this year. Growth in 1998 was short of the level needed to make a dent in unemployment. Moreover, the recovery has, to an unhealthy extent, been led by exports. In light of global conditions, expectations are that growth will dip below 2 per cent this year. Assessing the prospects has been made more complicated by the introduction of the Euro. Contrasting performances between larger and smaller economies, and the cyclical asymmetry with the United States, are posing policy dilemmas to the European Central Bank. But in the end, economic restructuring will determine the longer-term viability of the new currency.
Policy Options: The Ball Is in Industrial Countries’ Court
There is very little scope for effective policy responses in the developing world to the threat of a sharper downturn in global economic activity. Because of the possible adverse reaction of financial and currency markets, most developing countries would be unable to use expansionary monetary and fiscal policy to counter a deepening deflation.
The responsibility for action to stimulate world growth therefore falls on industrial countries. The United States has considerable room to use fiscal policy, should the risk of recession increase. The possibility of amending the EU’s Stability Pact in order to introduce greater fiscal flexibility should also be explored.
Both Japan and the EU are in a position to provide liquidity to developing countries by recycling their large current account surpluses. Regional aid schemes, such as the Miyazawa Plan, offer one possible blueprint. Other means should be considered, including immediate removal of the debt overhang of the poorest countries or the provision of a substantial new SDR allocation, to provide payments support to developing and transition economies.